When all the partners don’t agree on what to do with the proceeds from the sale of real property, executing a “drop and swap” allows real estate investors to “drop” real property ownership from the LLC to individual partners as tenants in common (TIC) prior to selling the real property. The “drop” to individual partners as TIC should take place prior to the sale, allowing as much time as possible for the property to be “held for business or investment purposes” by the individual tenants. As with all 1031 exchanges, there is no clear rule in the tax code about how long before a sale the property must be owned by the tenants in common.
When the property is sold (the “swap”), the proceeds are divided among the TIC. Each individual can then decide whether to cash out and pay taxes or reinvest into another investment property and continue to defer taxes.
Revenue Ruling 77-337 and Revenue Ruling 75-292 provide examples of exchanges that were disqualified due to transfers which occurred immediately before or after an exchange from or to an entity controlled by the taxpayer.
Partners will want to ensure that the partners not involved in the 1031 Exchange (those that want to cash out) truly drop their interests in the partnership. If not, the IRS may recharacterize their TIC interests to partnership interests. Refer to Rev. Proc. 2002-22 for minimum “drop and swap” criteria.
Be aware of two questions on the Form 1065, Schedule B:
Question 13 asks
“…during the current or prior tax year, the partnership distributed any property received in a like-kind exchange or contributed such property to another entity (other than entities wholly-owned by the partnership throughout the tax year)”
Question 14 asks
“At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property?”
It is best to negotiate and take title as individuals rather than entities.
Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.
Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.
The two primary accounting methods are accrual and cash basis
The main difference between the two methods is the timing of when expenses and revenues are recognized. There are advantages and disadvantages to both methods, so depending on your company’s operations and goals, you can decide which method best aligns with your company’s needs and preferences.
Consult with a Certified Public Accountant or tax professional to ensure the appropriate accounting method is used.
Accrual Accounting
Under this method, revenue is recognized when a sale transaction occurs and expenses are recognized when the purchase of goods or services occur, regardless of whether any cash was received or dispersed.
The Accrual method is more complex but provides a more accurate picture of a company’s financial position due to its recognition of payables and receivables. However, because some transactions are recorded before cash is actually received, a company’s revenue books will not be aligned with the current amount of cash in their bank account.
The Accrual method is most commonly used by publicly traded companies that are required to receive a financial audit and is accepted under the Generally Accepted Accounting Principles (GAAP).
One example of revenue recognition under the Accrual method: You work for a landscaping company, you mulched a lawn for a client and you invoice the client $200 on December 31. You will recognize revenue on December 31 because the service was performed that day, regardless of whether you received a form of payment from the client.
Cash Accounting
This method is known for its simplicity of keeping track of cash flow because revenue and expenses are accounted for only when cash is received or dispersed.
The Cash method gives you an accurate picture of the cash in your bank account today but does not account for payables or receivables; therefore, the risk of overstating the health of a company is present and does not provide an accurate representation of a company’s financial position. Typically, this method is most used for small businesses and sole proprietorships.
The Cash method is not acceptable under the Generally Accepted Accounting Principles (GAAP).
One example of a revenue recognition under the Cash method: Let’s use the same example from above. You work for a landscaping company, you mulched a lawn for a client, and you invoice the client $200 on December 31. You do not recognize revenue on December 31, because you have not received any form of payment. You will record revenue on the day you receive cash, a check, or a credit card payment from the client for your mulching services.
Why is it important to choose the correct accounting method?
It is useful to track your cash flow and understand the future of your company’s financial position
It is important for tax purposes in order to determine the accurate amount of annual taxes you will need to pay to the Internal Revenue Service (IRS)
It is important to ensure compliance of state and federal regulations. Some states have a preferred accounting method to be used by businesses
Can a company change its method of accounting?
Yes, but a tax return must be filed and approved by the Internal Revenue Service (IRS) before changing its accounting method. To make this legal change, Form 3115, Application for Change in Accounting Method, must be filed by the taxpayer.
Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.
Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.
The IRS Forms 1099 are a series of forms used to report certain types of income that do not come from a direct employer in the form of wages, salaries, tips, etc. The most common is Form 1099-NEC (nonemployee compensation), frequently used by small business owners.
The primary purpose of these forms is to give nonemployees (contractors or subcontractors) a record of total annual payments they received and need to report during tax time. When paying a nonemployee, businesses do not withhold or pay any employer taxes on those payments. When tax time comes, each individual or business who has received a 1099 is required to report this income and pay any related taxes.
Businesses and Individuals Required to file Forms 1099
If a business pays $600 or more in compensation through the year to a contractor or other nonemployee, the business is required to send copies of Form 1099-NEC to the IRS and payees. This form is typically issued to individuals, sole proprietors, partnerships, interest payees, rent payees, and single member LLCs (businesses are not required to send a 1099-NEC to S and C corporations). However, all attorneys receive a 1099, even if they are an S or C corporation.
The due date for filing a copy of a 1099 with the IRS and providing a copy to your contractors and vendors is January 31 for most businesses. If the business is not filing Forms 1099-NEC, the due date to submit any other type of 1099 is February 28. If either of these dates is on a weekend, the deadline falls on the following Monday.
Information required to file a 1099
Have all contractors complete a Form W-9. This will request their full name, social security number, and address (if it is an individual) or their business name, EIN, and address (if it is a business).
A total of all payments made to the nonemployee (contractor) throughout the year.
Electronic Filing Update – New IRS Portal
The IRS is scheduled to launch a new internet filing portal in early January 2023. Under Section 2102 of the Taxpayer First Act, the IRS is developing an internet portal that will allow taxpayers to electronically file Forms 1099 after December 31, 2022. Reference part F of the IRS Instructions for additional information.
Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.
Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.
Active Income (wages, business where the taxpayer is materially participating, etc.)
Passive Income
There are two kinds of passive activities.
1. Trade or business activities in which you don’t materially participate during the year
2. Rental activities, even if you do materially participate in them, unless you’re a real estate professional
3. Portfolio Income (royalties, capital gains, interest, qualified dividends, etc.)
How is Active Income is taxed? Ordinary tax rates plus self employment tax (SS and Medicare tax) of 15.3%.
For employees, SS and Medicare is automatically taken out of your paycheck and split 50/50 with employer. For someone who is self employed or active in a business, they must pay both halves of the SS and Medicare, known as self employment tax.
How is Passive Income taxed? Ordinary tax rates with no self employment tax. Subject to Net Investment Income Tax (NIIT) of 3.8% if your AGI is above the threshold of $250,000 for MFJ.
How is Portfolio Income taxed? Ordinary tax rates or preferential rates for LTCG and qualified dividends.
So this might seem that having passive income is better than active income. NOT NECESSARILY.
Losses: When you are an owner in a pass through entity (partnership, S Corp), you need to be careful with how you categorize your participation in the business because if the company is generating losses, you may not get to take them.
Passive Activity Losses (PALs): When a taxpayer has a loss from a passive activity, it can only offset passive income, NOT active income.
Example of passive investor and passive activity loss limitations:
Pete is an individual taxpayer who owns a 25% interest in an LLC. He is categorized as a limited partner and his 25% ownership interest is just an investment as he does not participate in the day-to-day managerial decisions of the business. This means that Pete is a passive partner. The LLC generated a $100,000 loss, $25,000 allocated to Pete on his Schedule K-1. Pete has a full time job where he makes a salary of $100,000.
It would appear that Pete can offset his $100,000 income from his W-2 with his $25,000 loss from his Schedule K-1, however, because the loss is passive and the income is active, Pete cannot deduct the $25,000 loss until he has passive income. Therefore, the loss rolls forward until the LLC generates income in a future year, or Pete has passive income from another income stream.
How do you qualify as material participation?
You participated in the activity for more than 500 hours.
Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.
You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test. See Significant Participation Passive Activities under Recharacterization of Passive Income, later.
You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.
The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.
Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.
Rental Activities
Rental activities are always passive unless you are a “Real Estate Professional.” There is a special $25,000 allowance for a taxpayer who actively participates in a passive rental real estate activity. So you can deduct up to $25,000 of passive loss against active income if you are deemed to have “actively participated” in the rental real estate activity.
Active participation- not the same as material participation. Active participation is a less stringent standard than material participation. Examples of active participation (management decisions, approving new tenants, deciding on rental terms, approving expenses, etc.).
**So basically any taxpayer can easily qualify as active participation as long as they are making high level decisions for the rental.
Real Estate Professional Status
You qualified as a real estate professional for the year if you met both of the following requirements.
More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated.
You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated.
Disclaimer: The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best course of action for your situation.
Mitzi E. Sullivan, CPA is a cloud based professional services provider specializing in cloud accounting.
Congress and the Trump Administration agreed to a deal for what will be the largest stimulus package in American history. Overnight, senators and the Trump administration officials reached a deal for approximately a $2 trillion stimulus to send direct payments and benefits to individuals and businesses devastated by the coronavirus pandemic. There will be a final vote today at noon and it is believed that the bill will unanimously pass and go into effect in the next few days.
The full details of the stimulus have not yet been released. The deal is expected to set aside $250 billion for direct payments to individuals and families, $350 billion in small business loans (https://disasterloan.sba.gov/ela/), $250 billion in unemployment insurance benefits and $500 billion in loans for distressed companies. As the plan was being negotiated, individuals who earn $75,000 in adjusted gross income or less would get direct payments of $1,200 each, with married couples earning up to $150,000 receiving $2,400 and an additional $500 per child. The payments would scale down by income and entirely phase out for individuals who earn more than $99,000 and couples who earn more than $198,000.
Although we are still waiting on the full and final details of the stimulus package, we are confident that people and businesses in need will have support from the government very soon. Members of Congress have also acknowledged that other legislative measures may be needed in the coming months if the pandemic continues to drag out.
Many of the loans and advances require current financial data and tax returns filed through 2018. Even if you still owe from previous years, make sure your tax returns have been filed through 2018. If you need any help getting caught up on your taxes and/or with loan applications, please reach out and we are happy to help. You can also follow us on social media to stay up to date on these events.
The U.S. Small Business Administration (SBA) has approved certain cities and states whose businesses have been negatively impacted by COVID-19 to be approved for the Economic Injury Disaster Loan.
On March 17th, Governor Greg Abbot requested emergency designation from the SBA Economic Injury Disaster Declaration to give access to the Economic Injury Disaster Loan program for the entire state of Texas. Abbot is estimating approval by next week. Small businesses can apply at: https://disasterloan.sba.gov/ela/.
The SBA has announced that the website is experiencing high volumes of traffic and slows down from 7:00 am to 7:00 pm. The best time to apply on the website is after peak hours from 7:00 pm to 7:00 am. It has been reported that some users are experiencing issues with Google Chrome. The SBA recommends using an alternate web browser like Microsoft Edge or Internet Explorer.
With COVID-19 impacting the world economy, President Trump has made plans to help strengthen businesses. Small business loans will be available to eligible organizations negatively impacted by economic slowdown. The Small Business Administration (SBA) has been instructed to provide low-interest loans to help strengthen organizations negatively impacted by COVID-19. To receive an Economic Injury Disaster Loan (EIDL) from the SBA, the organization must be in a county who has been approved for an Economic Loss Declaration. Small businesses who receive the EIDL are set to accrue interest at 3.75% and nonprofits at 2.75% with repayment terms extending up to 30 years.
In addition to the Economic Injury Disaster Loan program, “[President Trump] will be instructing the Treasury Department to defer tax payments without interest or penalties for certain individuals and businesses negatively impacted.” This tax holiday will give businesses a 90 day grace period to pay 2020 Q1 ES payments.
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